Leonard Silver v. Minister of National Revenue, [1976] CTC 2043, 76 DTC 1039

The Chairman:—This is the appeal of Leonard Silver from an income tax assessment in respect of the 1970 taxation year.

The issue before the Board is whether, in the circumstances of this appeal, Leonard Holdings Corp is a personal corporation within the definition of section 68 of the Income Tax Act, RSC 1952, c 148, and whether the Minister of National Revenue properly assessed the appellant by imposing a tax on dividends deemed to have been received by him personally in 1970.

There is no dispute between the parties as to the facts of this appeal which, according to the Statement of Facts filed with the Board, are as follows:

(1) That Leonard Silver directly and/or indirectly controlled Leonard Holdings Corp during its 1970 and 1971 fiscal years.

(2) That Leonard Holdings Corp, during its fiscal years 1970 and 1971, did not carry on “an active financial, commercial or industrial business”.

(3) That, during its fiscal years 1970 and 1971, Leonard Holdings Corp borrowed moneys In the amounts of $12,163.58 and $13,649.40, respectively from Leonard Fruit Co Ltd, a corporation in which it held shares. Said moneys were not repaid to Leonard Fruit Co Ltd prior to the end of the respective following fiscal years of Leonard Fruit Co Ltd.

(4) That, save for the loans set forth in paragraph (3) above, Leonard Holdings Corp had no income in its fiscal years 1970 and 1971.

As a first and principal submission, counsel for the appellant contends that, although Leonard Holdings Corp might well be taxed under 2044

subsection 8(2) of the Income Tax Act on unrepaid loans to share- holders deemed to have been received as dividends in the pertinent years, Leonard Holdings Corp was not a personal corporation and therefore the deemed dividends were improperly taxed in Mr Leonard Silver’s hands.

The appellant submits that paragraph 68(1)(a) and subparagraph eg(1)(6)(i) taken together state that a personal corporation is one

which derives Ya of its income from dividends, and counsel contends that Leonard Holdings Corp, though deemed to have received dividends pursuant to subsection 8(2), did not derive income from dividends as stipulated in paragraph 68(1)(b) and is, therefore, not a personal corporation.

In support of the legal distinction the appellant sought to make between the words “derived” and “received” in the pertinent provisions of the Act, counsel cited the case of Gi/hooly v MNR, 119451 Ex CR 141: [1945] CTC 203; 2 DTC 725, in which His Honour Mr Justice Cameron, then a Deputy Judge of the Exchequer Court of Canada, quoted with approval at page 153 [215] the following words of Henchman, J, of the Court of Review of Queensland, Australia, as

reported in a Queensland case, [1929] QSR 276 at page 284.

Is there, then, anything in the words in s 8, subsec 8, of our Act, “income

derived as dividends from any company,” to compel me to set aside this company” necessarily connote the meaning “received by the taxpayer from

the company as dividends”?

I do not think so. If that were the meaning, and if it had been intended to bring about a result different from that reached by the Victorian Court,

‘++ would have been easy to say “income received (or received by the tax- payer) as dividends from any company . .”. But the words are ‘derived as dividends”, and these words appear to me to be directed to the nature of the original source of the income, rather than to whether the ultimate recipient is the shareholder himself . . . [1]

Counsel submits that, although Leonard Fruit Co Ltd lent money to Leonard Holdings Corp, such a loan was not a source of income because, under the income tax legislation of both the Federal Government and the Province of Québec, a loan must be repaid, and he concludes, therefore, that Leonard Holdings Corp had no income from a source in the years pertinent to this appeal.

To the same effect, counsel cited the case of Lady Virginia Kemp v MNR, [1947] Ex CR 578; [1947] CTC 343; 3 DTC 1078, in which Mr Justice Thorson, then President of the Exchequer Court o‘ Canada, stated, at page 586 [3650]:

In my view, they support his opinion that income “derived from mining” meant “income originating from mining or coming from mining as its source” ....

Counsel for the appellant contends that paragraph 68(1 )(b) by analogy would mean income “originating from or coming from dividends, and that such terminology is not applicable to loans which by law must be repaid.

The appellant’s second submission, allegedly based on Mr Justice Noel’s decision in the then Exchequer Court of Canada in the case of Yardley Plastics of Canada v MNR, [1966] Ex CR 1027; [1966] CTC 215; 66 DTC 5183, is to the effect that a deeming section of the Act does not transmit the same presumption to another section of the Act. Counsel contends that, although subsection 8(2) may deem Leonard Holdings Corp to have received dividends, it does not follow that the company is deemed to have derived dividends for purposes of paragraph 68(1)(a).

On reading Mr Justice Noël’s remarks in the Yardley case, I did not find that he clearly supported counsel for the appellant’s contention, nor in my view did he enunciate so far-reaching a principle as counsel for the appellant suggests.

Counsel for the respondent, on the other hand, contends that, from the situation of fact there follows automatically a situation of law which cannot be overlooked, and he points out that Leonard Fruit Co Ltd made loans to Leonard Holdings Corp in each of the years 1970 and 1971 and that these loans were not repaid within the time specified in subsection 8(2), which reads:

8.(2) Where a corporation has, in a taxation year, made a loan to a shareholder, the amount thereof shall be deemed to have been received by the shareholder as a dividend in the year unless

(a) the loan was made

(i) in the ordinary course of its business and the lending of money was part of its ordinary business,

(ii) to an officer or servant of the corporation to enable or assist him

to purchase or erect a dwelling house for his own occupation,

(iii) to an officer or servant of the corporation to enable or assist him to purchase from the corporation fully paid shares of the corporation to be held by him for his own benefit, or

(iv) to an officer or servant of the corporation to enable or assist him to purchase an automobile to be used by him in the performance of the duties of his office or employment,

and bona fide arrangements were made at the time the loan was made for repayment thereof within a reasonable time, or

(b) the loan was repaid within one year from the end of the taxation year of the corporation in which it was made and it is established, by subsequent events or otherwise, that the repayment was not made as a part of a series of loans and repayments.

Counsel concludes that, under the circumstances, the loans made to Leonard Holdings Corp are deemed to be received as dividends pursuant to subsection 8(2) and therefore are dividends for income tax purposes. Subparagraph 6(1)(a)(i) states:

6.(1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year . . . (a) amounts received in the year as, on account or in lieu of payment of, or in satisfaction of (i) dividends, . . .

Counsel holds that, on the basis of these two provisions, Leonard Holdings Corp was deemed to have received dividends and should have included them in its income. Counsel therefore contends that, although Leonard Holdings Corp did not have income prior to 1970, it did have income in the form of dividends for each of the years 1970 and 1971 and that it then met all the conditions of a personal corporation as defined in subsection 68(1) of the Act.

Dealing with the legal distinction made by the appellant in the use of the words “derived” and “received” found in subsection 8(2) and paragraph 68(1)(b) of the Act, the respondent contends that the legislator, when enacting subsection 8(2), created a legal fiction by deeming that certain loans which are not ordinarily income are to be considered as dividends. The purpose of this “fiction in law” was to prevent corporations from distributing their income tax-free by making so-called loans to its shareholders.

The nub of the problem, as I see it, is simply whether or not Leonard Holdings Corp was a personal corporation in the relevant taxation years. If it was, then the Minister’s assessment of the appellant is correct. If it was not, then the deemed dividends cannot be taxed in Mr Silver’s hands.

The appellant’s principal argument, in contending that Leonard Holdings Corp was not a personal corporation, is that paragraph 68(1)(b), in establishing some of the conditions necessary to constitute a company as a personal corporation, states that at least /4 of its income must be derived from dividends. Counsel for the appellant contends that Leonard Holdings Corp did not derive its income from dividends and, as it does not meet the requirements of paragraph 68(1)(b), is therefore not a personal corporation.

In the case of Gilhooly v MNR (supra), decided by the Exchequer Court of Canada and cited by the appellant in support of the distinction to be made between the word “received” used in subsection 8(2) and the word “derived” used in paragraph 68(1)(b), it must be noted that the issue in that case was the appellant’s entitlement to depletion allowance on dividend income from an estate which was “derived from mining”.

The Court held “that the appellant was entitled to the depletion allowance of the income from the estate which was ‘derived from mining’ in the sense of being made up of mining dividends. The mere intervention of the executor was not sufficient, in the learned Judge’s view, to deprive the appellant of the right to deduct the depletion allowance which s 5(1)(a) of the Act, and long practice of the Department, accorded to the recipient of mining dividends.” (See 2 DTC 725.)

The facts of the Gilhooly case and the Kemp case cited by counsel for the appellant are quite different from those of the appeal before me and the distinction made by the learned Judge’s endorsement of the dictum of Henchman, J as quoted in [1945] Ex CR at page 153, is not only well founded but necessary in order to establish that, in those circumstances, the original source of the income was dividends derived from mining and not the estate through which the dividends were received.

In the present appeal the facts are that, pursuant to subsection 8(2), loans made to Leonard Holdings Corp are deemed to have been received by it as dividends. For Leonard Holdings Corp to be considered as a personal corporation, paragraph 68(1)(b) requires that % of its income be derived from dividends. In my view, however important the distinction between the words “received” and “derived” may have been in the determination of the Gilhooly and the Kemp cases, it has relatively little bearing on the facts of the appeal before this Board. Admitting that the words “received” and “derived” have different connotations, the provision in subsection 8(2) that loans made to shareholders are deemed to be dividends received is a legally established and enforceable concept, and the amounts coming under subsection 8(2) are, for income tax purposes, to be considered and treated as dividends.

In my opinion, the important aspect in this case is not the distinction between the words “received” and “derived” in interpreting subsection 68(1), but the fact that a loan made under the circumstances described in subsection 8(2) is deemed to be a dividend, and therefore becomes income. Once the loans made to Leonard Holdings Corp. have been deemed to be dividends pursuant to subsection 8(2), they are also dividends for the purposes of paragraph 68(1)(b), and since the Original, and indeed the only, source of the income received by Leonard Holdings Corp in 1970 and 1971 is the deemed dividends, the said corporation can, in my opinion, legally be said to have derived its income from dividends, and it therefore becomes a personal corporation within the meaning of paragraph 68(1)(b).

Whether or not the loans made to Leonard Holdings Corp were ultra vires, as suggested by counse! for the appellant, is immaterial for income tax purposes, since they were in fact made and accepted. Even though loans are not for other purposes considered as income, for income tax purposes subsection 8(2) deems them to be dividends and, subject to subsection 28(1) of the Income Tax Act, such dividends must be included in income.

Counsel for the appellant admits that Leonard Holdings Corp is rightly deemed to have received dividends in 1970 and 1971 pursuant to subsection 8(2), but denies that Leonard Holdings Corp is a personal corporation because, in his opinion, the company did not derive its income from dividends. Since the said dividends were the only source of income of Leonard Holdings Corp in 1970 and 1971, in my opinion the corporation has in law derived its income from dividends within the meaning of paragraph 68(1)(b).

Since Leonard Holdings Corp meets all the other conditions set out in section 68, I conclude that it is a personal corporation and that the dividends so received are taxable in the hands of its controlling shareholder, the appellant.

For these reasons the appeal is dismissed.

Appeal dismissed.

Thomas J Collins, Appellant,

and